A Japanese processed food company wouldn’t necessarily stand out as a prime investment idea, given the sluggish growth prospects in the Japanese domestic market. Ajinomoto (OTCPK:AJINY) is an exception, though, in large part because of the company’s efforts to position itself in growing emerging markets and improve the margins in its core Japanese market. Add in the potential for management to further revise and upgrade its non-food businesses and I think there is a credible case for bullishness here.

I’m expecting Ajinomoto to leverage low-single-digit revenue growth into mid-single-digit FCF growth, supporting a fair value about 5% to 10% higher than today’s price. The liquidity for Ajinomoto’s ADRs is not great, though, and I would encourage investors to consider the Japan-listed shares (2802.T) as a much more liquid option.

Expanding From A Strong Base

Ajinomoto traces its history back to the discovery/isolation of monosodium glutamate back in the early 20th century, and Aji-no-moto remains a key product for the company today. Ajinomoto has built on that foundation over time, creating a significant seasonings business in Japan based around products like Aji-no-moto, hondashi (a Japanese stock/soup base), other soups/stocks, and “menu seasonings” for the restaurant and industrial food trade.

Ajinomoto generates about a third of its revenue today from its Japanese food business, about half of which consists of the aforementioned seasoning-type products. The remainder is roughly equally divided between a strong coffee business (#1-#3 in various coffee types include instant formulations and more traditional forms) and a frozen food business that likewise enjoys strong share in categories like dumplings and seafood dinners. Ajinomoto’s Japanese food business is a well-established player not all that dissimilar to say Nestle (OTCPK:NSRGY), McCormick (NYSE:MKC) and others in their home markets, and the company enjoys solid double-digit margins (recently in the mid-teens).

The international part of the food business is where things get interesting for me. Ajinomoto generates around 40% of its revenue from its international food business, with the U.S. and Thailand contributing around half of that (combined), and growth markets like Indonesia, Vietnam, Brazil, and the Philippines contributing around one-quarter (also combined). This business is broadly similar to the Japanese business with the exception that coffee and beverages aren’t as significant in the mix – frozen foods are a little more than a quarter of the business, with seasonings, sweeteners, and various processed foods making up the remainder.

Ajinomoto is a top-10 brand in Thailand, Indonesia, Vietnam, and a top-20 brand in Brazil, and management has made no secret of its intention to drive growth through international expansion. While management needs to continually adapt its strategies to the changing realities of these markets, the company has made a point of trying to customize its offerings to national/local tastes. Margins in the international business aren’t as strong as in the Japanese food business (low double digits), but some of that is due to ongoing brand and market-building efforts.

As far as the U.S. business is concerned, growing its Windsor Foods frozen foods business is a key priority. This business is currently skewed towards ethnic items (about two-thirds of sales come from Chinese or Mexican cuisine products) and consumer markets, but building up its presence with commercial customers (including distributors like Sysco (NYSE:SYY)) is an area of focus.

Outside Of Food, The Technology Is Strong, But The Businesses Are More Mixed

From its founding, Ajinomoto has made a point of emphasizing research and development in amino acids and related products. That has led to a collection of businesses that contribute more than a third of the company’s revenue across business areas like pharmaceuticals, specialty chemicals, and animal feed products. These businesses are generally not as profitable as the food businesses, though, and how Ajinomoto management handles these going forward is a key pivot point for the company’s future performance.

The pharmaceutical business generates close to 10% of sales. Ajinomoto has pulled back from branded drugs (due in large part to Japan’s strict pricing controls) and has instead refocused around custom manufacturing, pharmaceutical intermediaries and active ingredients, and amino acid products with medical applications. This isn’t a bad business, but it feels like one that is “just sorta there”; it’s not a growth driver nor a drag, but I feel like it’s an underwhelming use of capital as is.

The specialty chemicals businesses include operations like cosmetic ingredients (and its own Jino cosmetics brand), chemicals/products used in electronics manufacturing, and agrochemical products. Like the pharmaceutical business, there’s nothing necessarily “wrong” with the cosmetics or electronics businesses, but I feel like they aren’t maximized under Ajinomoto’s current plans, and I’m not sure the management wants to take the risks that would go with making larger investments (in areas like R&D and M&A) to drive more meaningful growth down the line.

The animal feed business is a different story. A lot of the business here has been in bulk commodity products like lysine, threonine, and tryptophan, where the company has market shares around 15% to 25%. These are important products (lysine is added to corn-based feeds to improve bioavailability and nutritional value), but Ajinomoto really can’t differentiate itself, and management has chosen to scale down these businesses and try to shift them towards fee-based operations where the company can better leverage (and get value from) its capabilities without continuing as a bulk manufacturer. Ajinomoto does have some non-commodity businesses here, and I would expect the company to continue to work to develop products that leverage its know-how and offer meaningful margins.

The Opportunity

Ajinomoto generates a little under half of its revenue from Japan, and I would expect that percentage to continue to decline. While Thailand’s growth prospects are likely relatively limited for Ajinomoto (the company has been there are a long time and enjoys a strong market presence), markets like Indonesia, Vietnam, and Brazil offer double-digit growth prospects, as do markets like Nigeria. M&A is likely to figure into this process; Ajinomoto acquired a Turkish powdered seasonings company (Orgen) back in November of 2016, and I believe the company will continue to look for opportunities to acquire strong local/regional brands that fit in with its overall product focus (seasonings, frozen foods, and maybe beverages).

With the Japanese food business, the underlying volume growth potential in aging country with a low population growth rate is modest, but Ajinomoto is nevertheless taking advantage of the opportunities that are available. More recently the company has shifted toward developing more products for the “business-to-business-to-consumer” market, as prepared takeout food is becoming more and more popular in Japan (particularly with older consumers) and Ajinomoto can sell a broad range of functional ingredients to this market. In the U.S., I see Ajinomoto considering more tuck-in deals to build its seasonings and frozen foods offerings, as well as looking to expand its channels outside warehouse clubs.

What happens with the non-food businesses is less clear to me. I am encouraged that management is now focusing on running the animal feed business with a greater focus on margins and differentiated products. Looking at other businesses like pharma and fine/specialty chemicals, you could argue that this is a “if it’s not broken, don’t break it” situation, but I think there’s a chance to make these more businesses more dynamic (at the cost of somewhat higher risk and reinvestment needs). They could also be candidates for sale down the road.

I’m looking for low single-digit long-term revenue growth, with emerging markets offsetting the weaker growth prospects of Japan. Between management’s efforts to streamline its Japanese operations, the maturation of its established emerging market businesses, and the efforts to improve the profitability of non-food businesses like the animal feed operations, I expect margins to improve, and I think Ajinomoto’s FCF margins can creep up into the high-single digits over time, supporting a mid-single-digit FCF growth rate and a fair value about 5% to 10% above today’s price.

The Bottom Line

I don’t expect well-established packaged food companies to trade at big discounts, but Ajinomoto looks undervalued today, and I believe the company is likely to see improving results as the economies in Brazil and Thailand improve and as it continues to grow in large markets like Indonesia and Vietnam. I also expect the strategic changes to the animal feed business to start showing up over the next couple of years, and I think investors will like what they see from there. While the low ADR liquidity is an issue, those investors who are willing and able to consider the Japanese shares should take a closer look.

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